Friday, March 30, 2007

Debt and Taxes

Something that has not been discussed much is how official debt obligations pushed onto the middle class -- such as student loans -- are a form of taxation. It used to be the case that scholarships and grants were used to help a student pay for a college education. Neither scholarships nor grants are used much anymore. Grants were provided through taxation and scholarships were provided by wealthy benefactors who bestowed endowments to colleges and universities so that non-wealthy students could attain a college degree.

There used to be a value system among wealthy individuals called noblesse oblige. Sadly, it does not appear that the current generation of wealthy have been taught this value system.

What few people know is that until the changes in the bankruptcy law in 2005, income tax obligations were dischargeable under certain conditions while student loan debt was not except under exceptional circumstances. In other words, it was easier for a high-earning wealthy person who didn't pay tax obligations to get rid of their tax debt than it was for a poor college graduate to discharge student loan debt. Income tax obligations were routinely wiped out in bankruptcy automatically whereas a disabled person who owed student loans would have to (and still has to) file a lawsuit against the government (known in bankruptcy court as an "adversary proceeding") in order to have a chance at getting the unsecured student loan debt discharged.

By the way, what did these non-tax-paying people do instead of paying their taxes? They lived it up: big houses, fancy cars and vacations. They often were held up as shining examples of success in their churches and communities. If their friends only knew what I knew.

As accountants and lawyers say: "All great wealth starts with a crime."

Obligations to pay for health care and pensions are still dischargeable in chapter 11 bankruptcy proceedings. Chapter 11 is a reorganization bankruptcy mainly used by corporations, but also used by wealthy (or at least seemingly wealthy) but largely-indebted individuals. That is why I have suggested that we create a national health care system and expand Social Security into a national pension system. Large corporations will deliberately underfund pension obligations because they will be able to overpay executives and pay "retention bonuses" to executives before filing for bankruptcy.

By way of analogy, if a consumer debtor did what corporations are allowed to do in chapter 11 proceedings, the bankruptcy trustee would invalidate the consumer debtor's transfer of their property and the court would probably dismiss their bankruptcy without a discharge.

We need to change health care and pension obligations to a kind of "priority debt."

For those of you unfamiliar with bankruptcy law, let me explain what I mean. There are basically three levels of debt in bankruptcy: secured, priority and unsecured non-priority.

A secured debt is one that is tied to a piece of property (such as your home mortgage and car payment). Priority debts are unsecured debts that are non-dischargeable for public policy reasons. Examples include most taxes and child support obligations. Unsecured non-priority debts are all other debt obligations such as medical bills, credit cards, payday loans and signature loans. Student loan debts are unsecured non-priority debts that are non-dischargeable except for "undue hardship."

When the Bankruptcy Abuse Reform Fiasco ("BARF"), aka BAPCPA, was passed and signed into law in 2005, it made debt obligations that middle-class taxpayers would incur harder to discharge. The court fees were increased almost 50% (from $209 to $299 for chapter 7 and from $179 to $274 for chapter 13). Attorney fees also increased by about the same percentage. I used to be able to have someone come into my office, go over their financial information, analyze it and determine if bankruptcy was a proper remedy in about an hour. Then I could prepare the paperwork in about another hour. Now things are completely different. I have to have three different meetings with the potential client: one free consultation on the ramifications of bankruptcy, wherein I have to give them disclosure forms mandated by the new law, inform them of the cost, tell them about the credit counseling requirement, etc; then I have to have a separate meeting wherein I collect their 6 months of pay stubs for the Means Test calculations (which itself takes a couple of hours); then the rest of the paperwork takes another hour or two to prepare. Then I have to re-review everything before filing as the new law creates a new liability on me personally to verify that everything they told me is true.

I've gotten a little off-topic here. But the point is that more debt obligations that used to be borne by the wealthy are being foisted onto the middle and lower classes and the only safety net -- bankruptcy -- is being restricted and made more expensive to those who have the least ability to pay. Debt obligations (student loans, medical bills and loss of pensions) are becoming a hidden tax that only middle and lower class workers pay.

The question is: how long will working class Americans be willing to accept subsidizing the lifestyles of the rich and famous by taking on their debt obligations?

1 comment:

Anonymous
said...

Fred, another excellent one--this is just so spot-on. The middle-class in the US has fallen for a huge con job re: BK and they're about to find the price of blindly supporting republicans for the past 7 years--and the Repubs are about to discover the high cost of letting the party be hijacked by the Bushies.

Who Am I?

I am an Oklahoma attorney now working for the government. I was primarily a bankruptcy attorney, but now have moved on to new endeavors (again). The views expressed on this blog are (sometimes) my personal views and are not the views of my current employer.